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CMA Intermediate · Financial Management and Business Data Analytics · Payable Management

Kapoor Industries buys on '3/15, net 45'. Its bank overdraft costs 18% p.a. The firm can pay on day 15 using the overdraft instead of paying on day 45. Using a 360-day year and the simple formula, what is the better decision?

Kapoor should take the discount. Forgoing 3/15 net 45 effectively costs 3/97 times 360/30, about 37.11% a year, which is well above the 18% overdraft rate. Borrowing from the bank to pay early is therefore cheaper than the supplier's credit.

  1. ATake the discount; the cost of forgoing it is about 37.11%, above 18%Correct
  2. BForgo the discount; the cost of forgoing is about 37.11%, above 18%
  3. CTake the discount; the cost of forgoing it is about 18.56%, equal to the overdraft
  4. DForgo the discount; the cost of forgoing it is about 9.28%, below 18%

Explanation

Cost of forgoing = [3/97] x [360/30] = 0.030928 x 12 = 37.11%. This exceeds the 18% overdraft cost, so borrowing to pay early and take the discount saves money. The 18.56% and 9.28% figures wrongly use 360/60 or 360/120. Forgoing the discount would be wrong because the credit is costlier than the overdraft.

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